Obama clashes with yield showing bonds below growth outlook

As President Barack Obama starts his second term, the bond market is already telling him that the administration’s forecasts for economic growth over the next four years are too optimistic.

The Office of Management and Budget predicts yields on 10-year Treasury notes will rise to average 4.1% in 2015 and 4.9% in 2017 as the economy expands at about a 4% rate in the second half of Obama’s term. Bond prices suggest the yield, now at about 2%, will average below 3% two years from now, implying that gross domestic product will fall short of OMB projections, according to data compiled by Bloomberg.

While Obama’s legacy may depend on a recovering economy, the bond market is signaling GDP may not in the next few years exceed the 3.3% annual average of the decade preceding the financial crisis and tax revenues will fall short of what the president needs to close the budget gap. That’s not all bad news because Treasury borrowing costs just above last year’s record lows mean easy credit for consumers and companies as well as sustained demand for riskier assets such as stocks.

“Clearly, the bond market is on one end of the spectrum and these guys are on the other end, believing rates are going to go up so fast,” Priya Misra, the head of U.S. rates strategy at Bank of America Merrill Lynch in New York, one of the 21 primary dealers that trade with the Federal Reserve, said Feb. 8 in a telephone interview.

Not ’Normal’

“The 10-year yield rising to about 5% in four years is too optimistic,” Misra said. “Maybe you could argue that rates are a little depressed now, given inflows into bond funds and the Federal Reserve’s debt purchases, but this is nothing like a normal recovery.”

Market expectations reflected in bond yields are consistent with the median estimate of 84 economists in a Bloomberg survey who say the U.S. will grow 2.7% in 2014. The OMB forecasts 3.5% next year.

The clashing views come after the 10-year note yield fell as low as 1.38% in July and averaged 1.79% in 2012, the lowest since the debt was first issued in 1953. The next threat to Obama’s forecast is looming as Congress faces a March 1 deadline to avert spending reductions of $1.2 trillion over nine years that may cut growth in 2013 by half, according to the non-partisan Congressional Budget Office.

Colin Kim, director of the Treasury’s Office of Debt Management, noted the divergence between the market outlook and his agency’s assumptions during the government’s regular quarterly meeting with the Treasury Borrowing Advisory Committee on Feb. 5, according to minutes posted on the Treasury Department’s website.